Xerox is a global corporation that specializes in manufacturing equipment used for copying documents, as well as in developing technologies for other business processes and operations. This American company is headquartered in Norwalk, Connecticut (Xerox: Investor Relations, 2016). However, the company’s manufacturing facilities are located in many countries over the globe, and much attention is paid to investing in research, development, and manufacturing processes to remain competitive in the market (Xerox: Investor Relations, 2016).
Global trends in the electronics industry made Xerox focus on investing in emerging markets to increase the competitive advantage. The purpose of this paper is to suggest the specific methodology to evaluate the planned capital investments for Xerox, assess the impact of inflation on the processes, analyze differences in evaluating projects in the United States and globally, and discuss advantages of sensitivity analysis.
Methodology for Evaluating Capital Investments
The traditional method used for evaluating the capital investments in Xerox and other similar companies is the cash payback technique. The other methods include the calculation of the net present value (NPV), the focus on the profitability index (PI), and the estimation of the internal rate of return (IRR). The cash payback technique allows for calculating the period that is necessary to cover costs that are associated with the investment project (Weygandt, Kimmel, & Kieso, 2012).
The NPV approach is based on analyzing the present value and comparing it with the values associated with investments (McGuigan & Moyer, 2013). Managers accept the proposal for planning investment if the NPV is positive. The calculation of the PI is used to predict potential financial outcomes of accepting a certain proposal (Weygandt et al., 2012). The IRR is another discounted cash flow technique that is used in addition to the NPV approach (McGuigan & Moyer, 2013). Even though traditional methods can be discussed as effective to measure values related to the investment projects, it is also important to focus on predicting risks.
The additional methods that should be used to evaluate capital investments of Xerox in emerging markets include the Binominal Option Model and Black-Scholes Model (Gulati & Singh, 2013). These models are used to find the value of the option to decide whether to select this proposal for investment or not.
These alternative methods are effective to provide not only the quantitative analysis of options for investments but also the evaluation of alternatives with the focus on the company’s strategy (Gulati & Singh, 2013). It is important to note that these models are based on the use of the decision tree technique, and the methods of valuation are time-consuming, but the results provided with the help of these models can be used to see the complex picture related to potential benefits and risks associated with the investment.
Impact of Inflation on Planning Capital Investments
In addition to conducting the quantitative evaluation of capital investments, it is also necessary to focus on the potential impact of inflation rates on capital budgeting. The typical impact is associated with the situation when inflation becomes unexpectedly high. As a result, prices and costs associated with the project can increase, and the budget for investment that was planned previously can be discussed as not enough to cover spending (Baker & English, 2011).
Thus, inflation can influence the process of selecting investment projects, and the project based on the proposal that seemed to be beneficial can lead to significant losses for the company because of high inflation rates. In this case, to conduct an accurate evaluation of the planned investments, it is necessary to refer to the nominal prices approach instead of the real price approach that is often used by accountants and managers (Baker & English, 2011).
The reason is that the nominal prices approach allows for forecasting not only prices but also inflation rates. As a result, the risks of selecting the wrong proposal become minimal (Gulati & Singh, 2013). The received information can impact the manager’s decisions directly because such details as predicted costs and prices associated with the further profitability of the project are taken into account while choosing the proposal for capital investment.
Evaluation of Projects for Increasing Internal Capacity and Expansion
The approaches to evaluating capital investment projects that are related to national and international markets differ because analysts are interested in investments that can contribute to the company’s internal capacity or add to the company’s global expansion.
According to Klammer, Wilner, and Smolarski (2011), most US companies prefer to use discounted cash flow techniques to evaluate the projects associated with investments to increase the internal capacity. Therefore, modifications in the evaluation strategy should be based on combining different techniques that can be applied in different projects, depending on circumstances. The evaluation should also include the use of sensitivity analysis.
However, to assess investment projects that are important for the company’s expansion, it is necessary to refer to risk prediction and management techniques (Klammer et al., 2011). In this case, alternative methods of evaluating capital investments should be used to assess all risks while selecting the option to choose and the strategy to follow regarding the certain evaluation model. The modifications include the combination of this type of analysis with traditional quantitative methods and models, involving the inflation rates (McGuigan & Moyer, 2013).
The information received after evaluating options with the help of the real options approach or pricing models can influence the decision regarding the expansion because it demonstrates what risks can be expected while choosing this or that option. The expansion is an important decision for the company, and many factors should be taken into account (Gulati & Singh, 2013). Therefore, the combination of the quantitative capital budgeting analysis with the risk assessment can provide the necessary information to use it in decision-making.
Sensitivity Analysis for Evaluating Projects
While planning the expansion into the emerging markets, Xerox can also utilize the sensitivity analysis that allows for calculating the value of a certain alternative under different parameters that are set by managers. From this perspective, the first benefit of using this type of analysis is the possibility to determine what parameters or factors can influence the project development because their effects can be estimated easily (Gulati & Singh, 2013).
One more benefit that is associated with the use of sensitivity analysis is the possibility to determine what factors among the stated parameters can influence the project development significantly. Specialists in accounting and capital budgeting state that the identification of the most critical parameters and their further examination are important to support the choice of the alternative (McGuigan & Moyer, 2013). Also, it is necessary to note that the focus on the most critical parameters allows for identifying weaknesses in planning or estimations that are related to capital investment.
Therefore, the use of sensitivity analysis is important to increase the competitive advantage for Xerox because the detailed evaluation of all alternatives with the focus on all factors that can influence the project development becomes possible. As a result, when managers refer to the sensitivity analysis, the decision-making regarding the choice of proposals for capital budgeting becomes logical and supported (Weygandt et al., 2012). The competitive advantage increases because the company receives opportunities to make revenues higher, and much attention should be paid to the development of long-term investment projects that are important to increase the profitability of Xerox while referring to its progress in the emerging markets.
Conclusion
Capital budgeting is important for any company because efficient decisions regarding investment can lead to increasing the competitive advantage of the firm. Xerox plans the expansion into the emerging markets, and the reference to valuation methods that are traditionally used in capital budgeting can be not enough in this case. Therefore, the use of alternative methods should be proposed.
Furthermore, the effective decision is also based on the manager’s ability to focus on details. As a result, the impact of the inflation rates projected for a certain country should also be taken into account while selecting the option for investment. Finally, much attention should be paid to the performance of sensitivity analysis because this approach has many benefits, and this procedure is used when it is necessary to know the whole picture and make reasonable decisions regarding investments.
References
Baker, H. K., & English, P. (2011). Capital budgeting valuation: Financial analysis for today’s investment projects. New York, NY: John Wiley & Sons.
Gulati, S., & Singh, Y. (2013). Financial management. San Francisco, CA: McGraw Hill Education.
Klammer, T., Wilner, N., & Smolarski, J. (2011). A comparative survey of capital investment decision practices in the United States and the United Kingdom. International Business & Economics Research Journal, 1(11), 103-114.
McGuigan, J. R., & Moyer, R. C. (2013). Managerial economics: Applications, strategies and tactics. New York, NY: Nelson Education.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2012). Managerial accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons.
Xerox: Investor Relations. (2016). Web.